Pricing up your business

A keen surfer will rise early to find the best wave, and he will wait with quiet patience until the perfect drop occurs. Once he is on the wave, he enjoys the thrill and embraces the roaring ocean around him. But just as the wave reaches its crescendo, he pulls off. He lets the wave venture into the beach and he rides back out to catch the next perfect wave.

According to Trailer Homes’ Nick Young, brokers need the same attitude when it’s time to exit the industry.

“A broker should not be riding out his business until there is practically nothing left. Just as a surfer cuts out of the wave early, so too should a broker cut out of a business while it is still strong,” he says.

And that, according to Mr Young, is the true key to maximising the value of your business when you wish to sell.

“I see many brokers opting out of their business before it is even sold. While trail books do hang around for years, they deplete in value and if you are stepping back from your business, your clients will pick up on that and stop ringing,” he says.

“My advice to brokers is those who are looking to sell should sell long before they wish to exit.”

Around the industry

According to Kevin Agent of the Australian Lending & Investment Centre, many brokers are not able to articulate the value of their business.

“My view is that a majority of brokers are just in the industry for the lifestyle,” he says.

“I don’t think they realise what their book is actually worth.”

Meanwhile, Moshe Moses of Niche Lending believes a lack of education around business valuing in the industry means many brokers are unsure of their business’ worth.

“I think a majority of brokers have an assumption as to what their business is worth, but they don’t know the true worth because there are no set guidelines,” he says.

“I also don’t think a majority of brokers look at their worth and look at what their business is unfortunately, because they concentrate purely on income.”

Jeremy Fisher of 1st Street Home Loans agrees there is an obvious gap in the industry when it comes to knowledge around business worth.

“There is a lack of education in the industry and currently, brokers who are exiting the industry are selling their trail books at very low multiples,” he says.

However, with the industry’s ageing population, the discussion around the value of a broker business at sale time is a timely and opportune one.

But the question as to whose job it may be to educate brokers on the ways their businesses are valued is a contentious one; should it be the major banks and lenders? Should training providers get on the front foot with this issue? Or could it be the job of the individual broker to seek advice?

Mr Moses believes in all of the above. However, he suggests the aggregator groups have a substantial part to play in equipping brokers with the tools to determine their business’ worth.

“I think, in a majority of cases, the aggregators don’t feed the obvious information to their brokers,” he says.

“Aggregators tend to just continue to deal with brokers and don’t involve the broker on the value of their own business. They will discuss and help grow their business, providing various value-ads with discussion around the income that can be derived from that, but they don’t give a sentiment, they don’t say, ‘If you do this then the value of your book will increase by x’.”

Buying and selling activity

Anecdotally, a number of the brokers speaking with The Adviser believe there is a lot of buying and selling activity in the industry at the moment. So it seems an obvious conclusion that as brokers age, more will start to sell up in order to retire or move into less time consuming industries.

“We see it from both sides of the picture and I am seeing that there are people trying to buy up broker businesses and likewise, there is a significant amount of brokers willing to sell up their businesses for all sorts of reasons,” Mr Moses says.

With no centralised registry for sales or transfers of businesses, Jeff Zulman, managing director at Book Buyers Brokerage, says any figures are a projection.

“At Book Buyers Brokerage, we are involved in sales, financing acquisitions and arranging valuations, so we see a good cross section of the activity. I would estimate between 800 and 1,200 businesses or brokerages change hands every year,” he says.

Andrew Wynne, general manager of Advantedge Business Development, which offers a ‘buy and sell’ program, says as many brokers focus on growth, there are lots taking advantage of NAB’s program.

“Many brokers are focusing on growth in their existing businesses, whether organically driving new business or proactively through acquisition,” he says. “While focusing on their core offering is a priority for most brokers, a loan book acquisition can boost volumes, diversify brokers’ businesses into new product areas and increase cross-sell opportunities. However, brokers need to be aware it can be a complex process and we offer a ‘buy and sell’ program with the right experience and expertise to facilitate these transactions and do the due diligence required to buy or sell a loan book.”

Measuring a business’ worth

Valuing any business is a tricky task, but when you are determining the worth of a mortgage brokerage there are multiple considerations.

According to Mr Zulman, a valuer measures the business in two parts: “Tangible value and intangible value.

Tangible value is the physical assets of the business, such as furniture and most importantly, the value of the trail book and its future projected stream of cash flow, which is almost always the largest asset,” he says.

“The second part is intangible value goodwill. This is the trickier part to quantify or measure but looks at the value of the client database, the brand, processes and the intangible assets that contribute to the ongoing success of the business.”

Meanwhile, Mr Agent takes a simpler approach, saying “I’d determine the value of the business by how much a person is willing to pay for it.

“It comes down to how good your book is? If you’ve got a book that is stuck there for two, three, four years, low arrears, mainly investors, it would be worth more than a mum or dad book that would trail off in three or four years.”

Essentially, Mr Agent’s advice centres on a broker ensuring they do all they can to have a quality business up for sale.

Mr Zulman agrees, adding that a business’ past performance is a factor in determining the worth of the brokerage.

“Initially, we focus on how the trail book has performed in the past, as this is the best guide to likely future performance,” he explains.

“We have a complex scorecard that looks at factors including run-off, arrears, loan seasoning, concentration of risk with any lender or borrower group, average interest rate charged, mix of loan types and lenders and so on.”

Mr Wynne reveals that Advantedge measures a business through a transparent measuring standard.

“Our measurement standard uses a transparent price methodology to help brokers better assess and understand the value of a loan book,” he says.

“The fair value can be determined by carefully considering a number of factors, like borrower performance, diversity of lenders and claw-back history to name a few. Every loan book is different and should be looked at as a unique case.”

Increasing your value

While the formula to business valuing may not be foolproof, there are still many ways a broker can increase the value of their business before it’s time to sell.

Mr Fisher suggests brokers look after their Customer Relationship Management (CRM) systems.

“A good quality CRM can assist sellers in demonstrating their business as a growing company with a bright future rather than just a trail book,” he explains.

“To grow a business it is important to maintain communication with clients and referral partners. It also demonstrates value if a business can operate without relying on one key person.”

Rael Bricker of House + Home Loans in Western Australia says those businesses that display professionalism will prosper in the market.

“In this era of professionalism, a business is not just a trail book, it’s not just Mr Smith working from home, it’s now about personal assistance, staff and infrastructure. As soon as you build that around your business, you will have increased value,” he says.

Mark De Martino, director of sales at Loan Market, says brokers should be conscious of the lenders and products they offer to their customers to add value to their businesses.

“The database is the main factor and vitally important, but so too are the products,” he continues.

“If you ask a bank what the value of their brokers is worth, they potentially will say the amount of products they provide each customer, and I think there is certainly room for broker improvement in our industry around this.

“If a buyer can see you have a diverse offering of products, that will add value. For example, offering insurances to the customer, both income protection and general, conveyancing services, car loans and personal loans.”

What’s more, strong systems and procedures could potentially net you an easy extra 10 to 20 per cent on your sale price, according to Mr Zulman.

“If a broker wants to get that extra 10 to 20 per cent when they sell, it is a must,” he says. “But more than that, without these elements a broker is really not maximising the business’ true potential whilst they are the owners, which is a shame and a waste.”

Staying out of the ‘For sale’ bin

Mr Zulman reveals the top five mistakes brokers and business owners make that decrease the value of their business at the time of selling:

1. Not preparing the sale and business information in a clear and concise fashion, forcing the buyer to wade through reams of material and guess information rather than marvel at the efficiency

2. Unrealistic expectations about value – don’t be greedy. Initially, one attracts genuine buyers who move on when they can see it is too expensive. Meanwhile the business lies in the “for sale bin” growing stale

3. Be honest with potential buyers and intermediaries – no business is perfect, and trying to hide things is not only dishonest but destroys trust, which is essential to getting a buyer to pay full price

4. Share that you are looking to sell with your key staff. If they find out around the traps, they will fear they will no longer be needed. It destroys morale and worse still, can lead to a loss of your best people

5. The most obvious buyers are often right under your nose and are overlooked. A good adviser should take you through a process of identifying all of those prospects and should have the same financial incentive to ensure as successful a sale to a “known” party as to an “unknown”

The perfect buyer

When you are looking to sell your business, be aware that a buyer can come in all different shapes and sizes, and discounting someone outside of the industry can be detrimental to your sale.

“I know people at the moment who are not brokers, who are looking to buy and sell brokerages – from an investment point of view and from a return point of view,” Mr Moses explains.

“We have heard of real estate agents, financial planners and accountants looking to buy trail books, but it is happening in both directions.”

Mr Zulman says your own staff members may be the perfect fit, while Mr Agent believes aggregators should be assisting brokers more.

“The logical buyers are the aggregators. I think they should be buying the book and offering it to their members,” he says.

“For example, Connective or Vow should be buying these books off people looking to exit the industry and then going to their brokers and offering them for sale.

“I think the aggregators have a responsibility to people who do want to exit the industry to actually say, ‘Guys, we can help you transition your portfolio across’. It is good for those guys and it is good for people coming into the industry – sometimes they do need to have a book, so it is a good entry point for them.”

Case Study 1

Valuations

Loan book buying expert Nick Young of Trailer Homes takes a look at two broker businesses to determine the possible value of the companies

Small business

Nick’s valuation = $130,000

After aggregation fees, the loan book of $50 million should produce about $60,000 per annum in trail.

Trailer Homes (TH) would work with the broker, and potentially the broker’s aggregator, to achieve the following;

Day 1

TH buys the right to the annuity income from the existing trail book at 1.75 times annual trail – $105,000

New broker comes in and buys the goodwill associated with the business – the opportunity to write $9 million per annum. The terms of this acquisition might be 50 per cent of the upfronts generated from loans settled in the first 12 months following the sale

Day 2 – Day 365

The selling broker works with the buying broker to transition the business – eg. joint mailout to all clients, redirection of emails, and phone calls

The buying broker progressively pays the selling broker 50 per cent of the upfronts generated, which should equate to approximately $25,000

The buying broker receives the remainder of the upfronts, and all of the trail from income from the new loans generated from the acquired business

Year 2 onwards

The buying broker enjoys all the income from the acquired business

Summary

The acquiring broker has purchased the goodwill associated with the business entirely, using the cash flow of the acquired business.

The selling broker has received a total of $130,000 for his business, or approximately 2.2 times annual trail

Years in business: 5
Staff: 0
Broker count: 1
Loan book: $50,000,000
Loans settled: 15
Volumes: $9,000,000
Broker productivity: $9,000,000
Database: Well kept, personal
Location: Works from home

Case Study 2

Medium business

Nick’s valuation = $530,000

In order to work out some numbers, we must also assume the terms of employment associated with the brokers/staff

Assume:

After aggregation fees, the loan book of $170 million produces about $230,000 per annum in trail

Broker one is the owner and writes $25 million of the $50 million settled each year

Brokers two and three write the remaining $25 million between them and are employed on the basis they receive 60 per cent of the upfront and 50 per cent of the trails – ie. gross trails are $230,000 per annum, which after making assumptions about the share of trail, the two employed brokers might leave, say, $170,000 net trail (the owner’s share)

The staff member receives $60,000 per annum.

Trailer Homes (TH) would work with the owner/broker, and potentially the broker’s aggregator, to achieve the following;

Day 1

TH buys the right to the annuity income from the existing net trail book at 2.0 times annual trail – $340,000

New broker/owner comes in and buys the goodwill associated with the business, and takes on responsibility for staff, marketing and so on. The terms of this acquisition might be 30 per cent of the upfronts generated from loans settled in the first 12 months following the sale – whether written by the incoming broker, or the two employed brokers – and similarly, 30 per cent of the trails on all the new loans written. Then in year two, the revenue share on all loans written during that year might fall to 15 per cent of the upfronts and 15 per cent of the trails

Year 1

The selling broker works with the buying broker to transition the business

The buying broker progressively pays the selling broker 30 per cent of all the upfronts generated, which should equate to approximately $90,000 ($50m x $6,000 x 30 per cent)

The buying broker progressively pays the selling broker 30 per cent of all the trails generated, which should equate to approximately $6,000 ($50m x $1,500 x 30 per cent/2). The reason you must divide the trails by two is that they progressively feed in over the year

The buying broker receives the remainder of the net upfronts and the net trail from income from the new loans generated from the acquired business

Year 2

The buying broker progressively pays the selling broker 15 per cent of all the upfronts generated, which should equate to approximately $45,000 ($50m x $6,000 x 15 per cent)

The buying broker progressively pays the selling broker 15 per cent of all the trails generated, which should equate to approximately $3,000 ($50m x $1,500 x 15 per cent/2). The reason you must divide the trails by two is that they progressively feed in over year two

The selling broker also still gets 30 per cent of the trail from all of the loans written in year one – $11,000 ($50m x $1,500 x 30 per cent)

At the end of year two, the selling broker effectively has a new trail book producing $17,000 per annum, which they can sell to TH at two times. That is, $34,000

The buying broker receives the remainder of the net upfronts and the net trail from income from the new loans generated from the acquired business

Year 3 onwards

The buying broker enjoys all the net income from the acquired business

Summary

The acquiring broker has purchased the goodwill associated with the business entirely, using the cash flow of the acquired business.

The selling broker has received a total of $530,000, made up as follows:

$340,000 for his business’ initial sale of net trail income

$90,000 – 30 per cent share of upfronts in year one

$6,000 – 30 per cent of trails generated in year one

$12,000 – 30 per cent of trails paid in year two from loans written in year one

$45,000 – 15 per cent of upfronts generated in year two

$3,000 –15 per cent of trails generated from loans written in year two

$36,000 from selling new loan book at two times to TH

Given that as a starting point the owner was enjoying $170,000 net trail per annum, an all up sale price of $532,000 represents an all up multiple of 3.1 times.

What’s more, given the business has been operating for 15-plus years, the owner may be eligible for the up to 100 per cent capital gains tax relief available to small business owners on the sale of the trail books (brokers must seek independent advice from their accountants as to their own circumstances).

EXTRA KNOWLEDGE: TH has recently been involved in the sale of a business similar to this case study. Using a similar model to the above, the selling broker will achieve in excess of five times for his business.

Years in business: 15
Staff: 1
Broker count: 3
Loan book: $170,000,000
Loans settled: 100
Volumes: $50,000,000
Broker productivity: Broker 1 – $25,000,000, brokers 2 and 3 – $25,000,000
Database: Strong, monthly contact
Location: Small office, modest layout

What is an asset?

Nick Young of Trailer Homes busts some asset myths

The shopfront

Myth: A shopfront is an asset
Truth: Come sale day, it is actually a liability. A shopfront is a commitment to pay rent for a certain amount of time into the future. Then, at then end of that, it is a commitment to strip everything out to take it back to concrete to give back to the landlord. It is actually a commitment to pay money – that doesn't sound like an asset to me.

Furniture/computers

Myth: Furniture adds value
Truth: If you actually take really nice furniture down to an auction yard, it is not worth nearly what you think it is. It doesn’t add any value.

Brand

Myth: Good websites and CRMs are valuable
Truth: While this can be the case, I find a majority of small brokerages are sold to bigger businesses, which more often than not already have their own brands and websites, so they will effectively swallow that brand up – so they are not going to pay a lot of money for the brand.

What WILL earn you money?

Fact: A strong reputation will potentially add value to your sale price.

Fact: The thing that will make you money at sale time is what makes the phone ring. That’s the asset you’re selling – the right to answer the telephone. Someone bought your business and tomorrow the telephone is going to ring and they will earn an income from that.